Financial Advisors Can Improve Portfolio Performance by 3% a Year?

At a major ETF industry conference, Vanguard CIO Tim Buckley shared a preview of an upcoming report from by Vanguard Research. The general idea is that a good financial advisor should be able to affect the performance of client’s portfolio by three full percentage points. That’s a really big number, and I’m sure it has many advisors excited. Here’s how that 3% breaks down:

Buckley used the terms “controlling alpha”. Alpha is defined as excess risk-adjusted return above a benchmark, usually involving things like timing asset class movements and careful stock selection to make the difference. In contrast, the four factors listed above are less about being smarter than everyone else and more about avoiding simple mistakes.

This is still helpful advice, as these are the areas in which you should realistically expect assistance when looking for a financial advisor. It’s quite unlikely that the friendly person in the office building downtown is the next Warren Buffett. However, he or she may be the calming voice that you need to stay the course. I don’t know about 3%, but I do think a good advisor can invest better than many people on their own. As long as the advisor costs less than their “advisor alpha” benefit, you’ll come out ahead. The hard part, as always, is to find one of these “good” advisors.

Of course, being a DIY investor I feel I can do all these things myself. I also can’t help but notice again that many of these aspects are already rolled up into a nice balanced fund like the Vanguard Target Retirement 20XX Funds. By being all-in-one, the fund discourages trading and encourages doing nothing. The funds rebalance back to their target asset allocations automatically. The costs are extremely low. The only area where they come up short is tax-efficiency. However, for many individual investors the vast majority of their retirement assets are located in tax-advantaged accounts like IRAs and 401ks. In those cases, the benefits of tax-management are minimal.

It will be interesting to read the methodology behind the full report when it is published.

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This of course is a very “Vanguard like” perspective on what an advisory relationship should be — placing the client’s interest above everything else, particularly making commissions and fee income. I would bet that the “keeping cost low” criteria is where a lot fall short — and probably has a negative impact beyond the 0.5% indicated in the report.

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